Why and How to Time the Market

Since I first got interested in the stock market, I’ve been attracted to market timing. Maybe it’s my inherent risk-averse nature. Maybe it’s my contrary nature (my interest started back during the post-1995 boom and bubble, when no one cared about market timing). Or maybe it’s my interest in history, and the knowledge that big bear markets do happen, and when they do, they can set investors back years.

Today, of course, market timing is much more popular than it was 20 years ago, mainly because of the two huge bear markets in the last decade, and the uncertainty surrounding the world economy even today. I regularly talk to subscribers who tell me the first thing they look at in Cabot Market Letter is page 6, which contains all our timing indicators.

But apart from Cabot Market Letter subscribers, few investors really focus on market timing—they’ve been told by the “experts” that it can’t be done. And if they try market timing, many stop following it after a short time. Instead, they use gut feel and other people’s opinions (like what they hear on CNBC, etc.)—and that almost always leads to sub-par results.

The second (and less well appreciated) reason is that most investors simply can’t bring themselves to follow a system, even if it’s proven. It’s hard to sell any stock; selling involves giving up hope the stock can head higher. But it’s especially hard, psychologically, to sell when the stock still looks good, yet market timing says risk has increased. And thus, many investors don’t sell even when the market turns down.

However, I’m here to tell you that market timing can be done successfully—and you can train yourself to follow its signals. I should know—I used to be one of those investors described above! Back in the 2000-2003 bear market, I ignored the market’s downtrend for months … and got buried because of it. In fact, The Cabot market timing system had decayed by 2000, as the Internet bubble “taught” us that we didn’t need to worry much about the market’s trend; back then, our indicators had lost their effectiveness and our trust in their value was fading.

After that, Cabot’s founder Carlton Lutts (who also appreciated the value of market timing) and I sat down and devised a new market timing system. It was a system that helped us stay an average of 50% in cash from the bull market peak in October 2007 to the bear market low in March 2009—and it had us 90% in cash during the 2008 crash following Lehman’s bankruptcy!

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Our time-proven technical indicators are forecasting a major breakout ahead for a select group of stocks that continue to outpace the market by a country mile. In fact, the numbers we are seeing indicate that the stock market’s rocket ride to 15,500 is just the beginning of a bold new bull run.

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So how did we do it? By refocusing our efforts on trend following, which in my opinion is the single best way to time the market. What I like best about trend following is that it directly measures the market itself—this isn’t about momentum indicators (MACD, RSI, etc.), breadth, sentiment or something similar, which are all secondary indicators.

The biggest advantage of trend following is that it’s the only market timing system I know of that is guaranteed to keep you in every major market unmove, and guaranteed to keep you out of every major market downmove. I don’t use the word guarantee often (if ever!) when it comes to the market, but this one is true.

Trend following makes up 75% to 80% of my market-timing stance, and I do it via two indicators. The first, dubbed our Cabot Trend Lines, is longer-term; it looks at both the S&P 500 and Nasdaq Composite in relation to their respective 35-week moving averages. If both indexes close above their moving averages for two straight weeks, it’s a buy signal; below for two straight weeks, it’s a sell signal. Simple.

The Trend Lines also provide a background-type message—they tell you whether it’s winter (and you should expect frigid winds and snow squalls) or summer (pack up stuff for the beach!).

For the outlook for the intermediate term (the next few weeks), we rely on the Cabot Tides, which look at five major indexes (the Nasdaq Composite, NYSE Composite, S&P 500, S&P 400 MidCap and S&P 600 SmallCap) compared to their 25-day and 50-day moving averages. If three of the five indexes close above their lower moving averages on their charts, and those moving averages are advancing, it’s a buy signal. Sounds complicated, but it’s not.

The Trend Lines (longer-term) and Tides (intermediate-term) allow us to have a detailed picture of which way the market is trending. (If you’re a shorter-term trader, you might add a shorter-term trend following indicator, but that doesn’t fit my style of investing.) When both indicators are negative, that’s enough for us to be in a defensive posture … but when both are bullish (like today!), it’s enough to be at least leaning bullish, if not heavily invested!

(Now, there’s more to my market timing system than just trend following—I also track the action of leading growth stocks, sentiment and the action of the broad market—but I’ll save those topics for another Cabot Wealth Advisory!)

One of the quickest and easiest ways to improve your investing results is to incorporate market timing into your methodology. And for my money, trend following is the best approach—it will drastically cut your losses during downturns and still allow for big upside during bull trends. Doing just that will put you ahead of 80% of investors.

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So what’s going on in the current market? Things are looking a lot better than they did a couple of weeks ago—the Cabot Trend Lines and Cabot Tides are both positive, and growth stocks (my focus) are acting great, with many performing like champs.

That said, I still see a pretty meaningful divergence between the best growth stocks (which are doing great) and the broad market (which is so-so). Interest rate-sensitive securities remain under pressure, of course, but the broad market is also sluggish. For instance, when the Nasdaq hit a peak in mid-July, 401 stocks hit new highs. When the Nasdaq nearly touched 3,700 at the start of August, just 311 stocks hit new peaks. And this Tuesday, when the Nasdaq reached 3,730, just 207 stocks reached virgin turf.

Now, divergence isn’t a core feature of my market-timing system; it’s more descriptive than predictive. But what it is describing is a narrowing advance, which often leads to some potholes (sometimes large potholes) in the future.

This isn’t to say I’m distrusting my market-timing indicators. Not at all! But when it comes to new buying, it’s imperative to be in the right stocks, and to be in them at the right price, so that you can survive any shakeouts that may come.

One area that hasn’t been in the public’s eye but seems to be emerging is the energy group. I know what you’re probably thinking—aren’t oil stocks just getting a lift because oil prices have been up during this Syria uncertainty? Maybe, but I saw many names in the group act well even when oil prices dipped this week.

One of the best acting stocks is Pioneer Natural Resources (PXD), which I wrote about in Cabot Top Ten Trader back on August 5:

“Pioneer Natural Resources is a good-sized energy explorer that’s operating in two of the more exciting plays in the U.S.—the Wolfcamp/Spraberry area, which is one of the largest oil fields in the entire world, and the emerging Eagle Ford Shale, which is liquids-rich and could end up being the most lucrative shale play in all of the U.S. Pioneer’s total production this year is expected to grow “only” 14% to 16%, but investors are focused on the company’s activity in these two areas and liking what they see. In the Wolfcamp/Spraberry play, production increased 7% sequentially in the second quarter as the company moves more of its drilling to horizontal from vertical; this production was strong especially as some output was “rejected” because of low prices. In the Eagle Ford Shale, output was up only a smidge in the second quarter, but should grow 35% to 50% for all of 2013 as Pioneer ramps up the number of wells it’s tapping. Also of note are advancements like pad drilling and cheaper propants, which are saving hundreds of thousands of dollars per well. Obviously, a collapse in oil or liquids prices would be bad, but analysts see earnings up 42% this year (to about $4.90 per share) and another 26% in 2014. It looks like an emerging blue-chip in the energy sector.”

Since that time, PXD pulled back for a couple of weeks with the market, dipping from 183 to 166, then rallied back to that old peak before a small retreat this week. I think the stock’s a good buy around here, with a stop near 165 in case things go awry. If the oil group is starting a new uptrend, PXD should be one of the leaders.

Cabot Wealth Advisories

Cabot Benjamin Graham Value Investor uses the methods developed by the father of value investing, Benjamin Graham, and popularized by Warren Buffet. A system that works well in all markets, it buys stocks when they're dirt cheap, and sells when they've reached full valuation, a process that takes two years for the average selection. What's important here is buying only when a stock's price is below its Maximum Buy Price, holding through thick and thin, regardless of the news or the action of the stock, and then selling when the stock reaches its Minimum Buy Price. These are great stocks to own if you're a conservative stock investor. Chief Analyst J. Royden Ward explains clearly how to build a portfolio of stocks that meet his strict requirements-plus every issue includes updated rankings on his "Top 275 Value Stocks," so you can check on other stocks you may own.

Cabot Dividend Investor focuses on preparing for retirement, recommending a solid range of income-generating stocks, preferred stocks, REITs, MLPs, closed end funds and utilities, with particular emphasis on risk, dividend safety and dividend growth. If you’re retired or thinking about retirement, this advisory is designed for you. Cabot Dividend Investor’s proprietary Individual Retirement Income System (IRIS) will help you allocate your assets for capital appreciation, current income, growth and future income investments according to your retirement goals.

Cabot Emerging Markets Investor focuses on the emerging markets economies, with special attention paid to the BRIC (Brazil, Russia, India and China) investment landscape. You'll discover the value of international diversification and the profit potential of investing in countries whose economies are growing far faster than that of the U.S. All these stocks are traded on U.S. exchanges, usually as American Depositary Receipts. Under the guidance of Chief Analyst Paul Goodwin, Cabot Emerging Markets Investor was recognized as the top investment newsletter in 2006 and 2007 by Hulbert Financial Digest, and was rated by Hulbert as one of the top investment newsletters in every five-year period 2004 to 2011.

Cabot Growth Investor is our flagship investment advisory. Published since 1970, it is recommended for all investors seeking to grow their wealth. As a subscriber, each week you'll receive clear and comprehensive updates on the stocks recommended in our legendary Model Portfolio. You’ll also be kept apprised of the status of Cabot's proprietary market timing indicators so you’ll retreat to the safety of cash in every major bear market, and you’ll be aggressively invested in the best growth stocks in every major bull market. Furthermore, you’ll learn invaluable investing lessons, so that you won’t just become a more successful investor—you’ll become a wiser investor!

Cabot Options Trader’s Chief Analyst and options expert Jacob Mintz uses calls, puts and covered calls to guide investors to quick profits while always controlling risk. Beginners and experts alike can benefit from following Jacob’s advice. Whenever Jacob determines the time is right, he sends specific option buy and sell alerts via email and text-message for immediate action. He also sends out a weekly update with his views on the options market, open option positions and his outlook for the coming week.

Cabot Options Trader Pro’s Chief Analyst and options expert Jacob Mintz uses the full spectrum of option strategies to recommend the option that best suits the trade opportunity—calls, puts, spreads, straddles, iron condors and more—while always controlling risk. Whenever Jacob determines the time is right, he sends specific option buy and sell alerts via email and text-message for immediate action. He also sends out a weekly update with his views on the options market, open option positions and his outlook for the coming week.

Cabot Small-Cap Confidential is a limited-circulation advisory for investors seeking profit opportunities in high-potential small company stocks. Each month, small-cap expert and Chief Analyst Tyler Laundon features in-depth research on one outstanding small-company stock that is a pioneer in its field and undiscovered by institutional analysts. Updates on all recommended stocks are sent weekly. The circulation of Cabot Small-Cap Confidential is strictly limited because the stocks recommended are often low-priced and thinly traded. In the publication’s first five years, spanning 2007-2012, the average stock recommendation gained 30.5%.

Cabot Stock of the Week offers the very best of all Cabot stocks across the investing spectrum. Each stock is personally selected by Cabot’s President and most Senior Analyst Timothy Lutts, and guided by the collective wisdom of all the Cabot expert analysts. As a subscriber of Cabot Stock of the Week, you’ll build your wealth and reduce your risk with the single best stock each week for current market conditions among growth, momentum, emerging markets, value, dividend and small-cap stocks.

Designed for experienced investors, Cabot Top Ten Trader is your ticket to fast profits in stocks that are under accumulation now. Every Monday you’ll receive a one-page profile of each recommended stock, including fundamental analysis, technical analysis and buy ranges. Plus... each Friday, Chief Analyst Michael Cintolo will give you an update titled "Movers & Shakers," so you’ll always know his latest thoughts on these fast-moving stocks. Cabot Top Ten Trader is your best source of advice on investing in the market’s hottest stocks.

Cabot Undervalued Stocks Advisor peels back the curtain of glamour and volatility that surrounds the stock market, to assess good stock-investing opportunities without being spooked by sensationalized daily news stories. Chief Analyst Crista Huff’s goal is to assist you in outperforming the major U.S. stock market indexes, while minimizing risk by screening many hundreds of stocks for growth, value and bullish technical charts. Crista presents three portfolios: Growth, Growth & Income and Buy Low Opportunities, with specific Buy, Hold and Sell advice.

Wall Street’s Best Dividend Stocks presents the best income investments from the top Wall Street analysts, researchers and advisors. Editor Nancy Zambell scours more than 200 advisories and research reports to select the top recommendations. Dividend recommendations include high yield, growth and income, REITs, mutual funds, ETFs and more. One Spotlight Stock is featured each month, along with Nancy’s insight on the market and updates on past recommendations. One top recommendation arrives in your email box each morning, and then gets collected into an easy-to-read digest of 30 to 35 top recommendations each month.

Wall Street’s Best Investments presents the best ideas from the top Wall Street analysts, researchers and advisors. Editor Nancy Zambell scours more than 200 advisories and research reports to select the top recommendations. Investment recommendations include growth stocks, value stocks, technology, small-caps, biotech, pharmaceuticals, mutual funds, ETFs and more. One Spotlight Stock is featured each month, along with Nancy’s insight on the market and updates on past recommendations. One top recommendation arrives in your email box each morning, and then gets collected into an easy-to-read digest of 35 to 40 top recommendations each month.

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Market Update

From Cabot Small-Cap Confidential:

The S&P 600 Small Cap Index is up in 20 of the last 24 days.

The stock market has been having quite the party over the past month. Since November 8, the date of the election, the S&P 500 is up by 4.8%. Small caps have crushed that performance, rising by almost 16% over the same timeframe. Much of that outperformance can likely be attributed to a more favorable relative valuation (as compared to large cap) heading into the election. And an even better outlook coming out, given what is expected to be a pro-growth administration. Given the outlook for a pro-USA administration as well, which favors small caps over large (given their 19% ex-U.S. revenue exposure vs. roughly 30% ex-U.S. for S&P 500), we essentially wound up with a pro-small cap-squared backdrop. Everything has been working.

Alert

Many top earnings winners pulled back during the two-day Brexit selloff. I want to initiate a bullish position in Applied Materials which stood out after
blowing away earnings estimates. While I like the stock, I believe that there may be limited upside in most stocks, so I want to initiate a buy-write,
which sells expensive options.

To execute this trade, you need to:
Buy AMAT Stock,
Sell to Open the August 23 Calls.

As is always the case, you can sell one call for every 100 shares of stock you buy. Or five calls for every 500 shares you purchase.

For example, you could buy AMAT stock at 23 and sell August 23 Calls for 1.00 (the math behind this net price is 23 minus 1 equals 22).
I expect you will get a better price than I'm recommending.

The most you can make on this trade is $1.00, a yield of 4.54% in just over a month if AMAT closes above 23 on August expiration.

If AMAT is unchanged on August expiration, we will have created a yield of 4.54%.

Breakeven on this trade is 22.

The most you can lose on this trade is $2200 per buy-write if AMAT were to go to zero.

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